Will You Pay Taxes When You Sell Your House?

Deciding to sell your house is a big decision.

One of the most pressing matters is how much you can hope to see from the sale. It might not be the main reason you’re thinking about selling, but if the amount is too low, you’ll probably wait another year or so.

When thinking about potential returns, it is absolutely essential that you know whether or not you’ll have to pay taxes when you sell your house.

Do You Need to Pay Taxes When You Sell Your House?

As the old saying goes, there are two certainties in life: “death and taxes.”

So, it’s understandable if you assume that the government is waiting to take a nice big chunk of your profit margin once you sell your house.

However, the truth is that Uncle Sam is actually pretty generous when it comes to determining how much you owe them from that sale.

Prior to 1997, the IRS allowed a homeowner to sell their house and write off up to $125,000 in profit provided they were under the age of 55 and the house was their primary residence.

That has since changed.

Fortunately, it’s changed for the better.

Nowadays, the IRS' Publication 523 (2018), Selling Your Home allows you to write off up to $250,000 in profits from the sale of your home. If you’re married, you and your spouse are allowed to increase that write-off to $500,000.

Calculating the Taxable Gains on Your House

That’s all well and good, but before you can enjoy a massive write-off on the sale of your home, you need to understand how to calculate your taxable gains. Otherwise, you may actually need to pay taxes when you sell your house.

Again, there’s good news here because the calculation is actually very simple.

All you need to do is:

Take the amount you originally paid for your house
Add to that any money you spent over the years on improving it
Subtract from that total any of the costs involved with its sale

For example, say you bought your home for $200,000. Over the past 10 years, you spent another $50,000 on improvements.

You then sold your home for $300,000, but you used SimpleShowing, so you only paid $12,000 (4%) in commission. That would make your “take home” amount $288,000.

In that case, your capital gains would be $38,000, because that’s the difference between how much you spent on your house (the purchase price plus improvements: $250,000) and how much you received from the sale ($288,000).

As that’s under the IRS’ threshold for its tax-free gain program, you wouldn’t have to pay any taxes on those profits.

What Happens if You Go Over the Nontaxable Limit?

What happens if you discover that your capital gains actually exceed the $250,000 or $500,000 limit?

In that case, you will have to pay taxes on the surplus amount.

If you’ve lived in the house for more than a year, though, you’ll only have to pay taxes at the capital gains tax rate.

Otherwise, you’ll need to pay at the normal income tax rate for your bracket, which will be significantly greater.

What You Must Know About the IRS' Tax-Free Gain Program

With all this being said, not everyone can take advantage of the IRS’ tax-free gain program.

It’s best to go through the IRS’ eligibility test to make sure you qualify.

However, it’s fairly straightforward.

You usually won’t qualify if you acquired your house through a 1031 exchange during the last five years (there’s an exception we’ll explain in a moment).

The same applies if you have to pay an expatriate tax.

Otherwise, you’ll qualify for the IRS’ tax-free gain program when you sell your house if you meet the following requirements:

Ownership: You must have owned your house for at least two of the last five years. If you’re married, only one spouse needs to fulfill this requirement.
Residence: You also must have lived in the home for 24 months during those 5 years. Those months don’t have to be concurrent, though. However, if you’re married, both of you will have to fulfill this requirement to enjoy the $500,000 write-off.
Look-Back: You can only take advantage of this exemption once every two years. So, looking back, if you already sold a home in the last two years and wrote off your gains, you’ll have to pay taxes when you sell your current house.

Again, it’s worth going through the eligibility test for yourself, because there are some very specific exceptions that could apply if you fell short of any of the other requirements. These exceptions apply to anyone who meets one of the following conditions:

You got divorced or separated while you owned the house
Your spouse passed away while you owned the home
The sale of the house includes vacant land
You own a remainder interest in the house
A house you owned in the last five years was destroyed or condemned
Being a service member kept you from living in your house for 24 months
If you acquired your home through a 1031 exchange, you may still qualify if you meet all the other requirements

Even if you don’t qualify and have to pay taxes when you sell your house, you may still be able to write off some of the profits. To find out if this applies to you, read over the IRS’ Does Your Home Qualify for a Partial Exclusion of Gain?

Speak to an Expert Real Estate Agent Before Selling Your Home

You should now feel confident about whether or not you’ll have to pay taxes when you sell your house.

Nonetheless, this is clearly an area where you want to be 100% sure. You’d hate to sell your house expecting a handsome profit only to learn that you’ll actually need to pay capital gains taxes on it.

That’s just one more reason to work with an experienced real estate agent who will make sure you understand what to expect before you sell your house.

Use SimpleShowing and you’ll save by working with a 1% realtor while still enjoying a number of other important benefits.

Conclusion

Understanding the intricacies of capital gains and how it impacts your personal finance is crucial when you're preparing to sell your house. You can potentially avoid capital gains tax if you meet specific criteria related to the capital gains exclusion, which is particularly beneficial for those selling their primary residences. However, if you're selling an investment property or rental property, you may have to pay capital gains tax depending on the duration of ownership, differentiating between short term capital gains and long term capital gains.

Calculating capital gains tax accurately is imperative to ensure you don't end up with an unexpected tax bill. This involves determining your cost basis, factoring in closing costs, and comparing it against your sale price to identify your capital gain. Any taxable income from the sale needs to be declared accurately to avoid complications.

However, remember that tax laws can be complex and often require expert interpretation. Thus, it's always advisable to consult with a tax professional when dealing with potential capital gains. They can guide you in understanding if you owe taxes and how much you'll need to pay, considering either the ordinary tax income rate or the rate applicable to capital gains. This expert advice can be vital in navigating your tax obligations responsibly when selling a property.